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ASSIGNMENT BAO3306 AUDITING

REPORT Shan Gao s4520669 Yiman Sun s4520660

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Tutorial class： 3-4 pm Wednesday

Semester 1, 2018 Content

Executive summary.................................................................3 Introduction............................................................................................................4

Key information.....................................................................................................5 Understanding the client....................................................................................5 Identify 5 significant accounts most at risk of being materially misstated........7 Materiality level.................................................................................................7 Assessment of what can go wrong.....................................................................7 Conclusion............................................................................................................10

Appendix..............................................................................................................11 Reference..............................................................................................................13

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1. Executive summary In this audit plan assignment, it will help the auditor and audit manager to prepare the audit plan of the Nanosonics Company. In the part a, we simply make some introduction about the basic information of the client company which include the industry, financial performance, accounting policies, nature and objectives. Moreover, in the part b, we identify 5 significant accounts which most at the risk of being materially misstated, which are accumulated losses, sales of goods and services , cash and cash equivalents , net deferred tax assets and income tax benefit/ (expenses). For the part c, we calculated the materiality level of the company by using the sales of goods and services. Finally, in the part d, we use the audit risk model to show which account go wrong based on part b.

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2. Introduction Audit plan is the first step of auditing work and the basis of auditing work. If we accept a new customer under the situation of the audit plan, we may have a preliminary understanding of the completeness of the customer and then think about the acceptance of the engagement. If the credit and reputation of the client are good and we have both time and ability to audit the client, we will enter into the negotiation. In this period, both sides may clear their responsibilities, and then we will sign the engagement letter. After that, we will formulate a comprehensive audit strategy and make the specific audit strategy. In this assignment, we may completely follow the formal audit plan, which include the information of the company; 5 significant accounts which being materiality misstated; the materiality level of the clients according to the annual financial report and finally make a judgment of the 5 accounts using the audit risk model.

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3. Key information a) Our understanding of the client In this project, our client is Nanosonics Company which set up in 2000 in Sydney. The company mainly focus on the infection prevention and the disinfection of hospital utensils. It entered into ASX in 2007 and has become one of the ASX200 Index in 2016 (Nanosonics’ Story, 2017).Its unique product trophon® in HLD has entering all round the world and it has created new standards for the whole industry. 1. Industry, regulatory and other external factors The infection prevention is a huge and developing industry in the world. It is a market that with an annual growth rate of 6.2%, reaching $231 billion in 2023 (Infection Prevention Market Overview, 2015). In Australia, with the high rapid of aging situation and the increasing number of the population due to the immigration these years, there will be an increase in the number of people who go the hospital regularly. Thus the demand of the disinfection of hospital utensils will also increase and as a result, it may bring the huge potential prospect for the whole industry. For Nanosonics Company, there are not direct competitors for the company and its competition only limited to the old methods. What’s more, as a listed company, it should follow the ASX Listing Rules and the ASX Corporate Governance Principles. Additionally, the board may continue to follow the corporate governance to deal with the market conditions (Nanosonics Annual Report, 2017). 2. Measurement and financial performance The remuneration policies of the company are aimed to attract, retain and encourage the employees (Nanosonics Annual Report, 2017). That is to say, it will be use to achieve the sustainable growth of the company and create the shareholders’ value in both short and long term through the remuneration framework. In the short term, the measurement for the financial performance is based on the financial objectives like sale revenue and profit and loss. Also, it is based on the achievement of the financial performance at the beginning of the financial year. About the long term, earnings per share, revenue and vesting outcome are major measurements for the financial performance. What’s more, profitability ratios like gross profit margin and operating expenses margin and accounting ratios such as liquidity and solvency are the viable method to measure the financial performance (Nibusinessinfo, 2018). 3. Objective and strategies and business risk The objectives and strategies of the company can be divided into several parts. About the customer experience, the company concentrate on building our products as a new global standard of care and offer the customer relevant experience. Also, the growth strategy in this part is mainly about the geographical expansion especially in the Japanese market. As for the product innovation, the company needs to establish innovative product portfolios as the objective to satisfy the customers’ needs. What’s more, the value creation about to company is to create sustainable shareholder value and provide high returns. In all, the company is now

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entering into a long-term strategy which pays more attention to the geographical and product line expansion (Nanosonics Annual Report, 2017). For the business risk, the company now facing some material business risk like competition, distribution customers, supply chain and etc may have negative influence to the company. Thus, the company needs to set up some relevant solutions to get rid of these risks. 4. Accounting polices The Nanosonics Limited is a publicly listed company; also, it is a for-profit entity in Australia. The financial reports prepared by the company are obeying the AASB and Corporations Act 2001, IFRS and IASB (Nanosonics Annual Report, 2017). Generally, the consolidated financial statement was based on the historical cost except some assets and liabilities which calculated by air value. In the financial statement, there are some accounting policies. The first one is functional and presentation currency which may calculate in AUD. The second one is foreign currency which accounting policy is to use rate approaching the actual exchange rate on the date of the transaction. The third is about the revenue, the accounting policy for revenue is to measure in the fair value rather than historical costs. Finally, about the accounting policy of the consolidation eliminated, all the transactions in the consolidation have been fully eliminated (Nanosonics Annual Report, 2017). 5. Nature of the client a. Organizational structure The parent company is Nanosonics Limited which has 5 branches include the US, UK, Canada, French and Germany. For the shareholders, there are 10 main shareholders of the company and the JCP Investment Partners Ltd is the largest one which accounts for 8.35% of the total shares and Fidelity Management & Research Co (7.71%) ranked second. About the executive board, the CEO controls the whole the company while the CFO takes the charge of the financial statements. Both of them provided the written assurance based on sound risk management and internal control system. b. Governance structure The board of the directors of the company may obey the Corporate Governance Standard and the ASX Listing Rules. c. Mission of the client The mission of the company is to enhance the patients’ safety and the environment by changing the way to prevent infection. d. Employee benefits The employee benefits can be divided into short term and long term. Short term employee benefits are counted in discounted terms during the time of service delivery while the long term benefits are allowed to be discounted in the future period (Nanosonics Annual Report, 2017).

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b) Our assessment of significant accounts To figure out the top five significant accounts which are most at risk of being materially misstated, we use analytical procedure during the planning stage of audit. It is most common to use the simple comparisons method. It is necessary to compare each account balance of Nanosonics of 2017 and 2016 in financial statements such as income statement and balance sheet, and then calculate the differences between them. The significant accounts are those with the biggest differences. After the calculation, it is found that in Nanosonics, accumulated losses, sales of goods and services, cash and cash equivalents , net deferred tax assets and income tax benefit/(expenses) have the material movements in the balance between two financial years with the gaps equal to $26 million, 24.7 million, 14 million, 14 million and 12 million separately. The calculation process is in Appendix.

c) Our planning materiality In this part, we need to calculate the materiality level of the company. According to the financial report, the sales of goods and services for the company in 2017 were $67.5 million. Thus the materiality level is 0.5%*$67.5 million= $337,535. However, if the information has changed due to annual report of different years, the adjustment of the materiality level will be made accordingly.

d) Our assessment of what can go wrong 1. Sales of goods and services The company identifies that its sales of good are recognized when material risk and rewards are move to the distributors and customers and its sales of services are recognized when services are provided to customers. Sales of goods and services are an essential part of revenue, which will be totally affected by the industry related factors such as the changes in market share and demand for the products, and also be influenced by difficulties in auditing transactions and mistakes of prior audit (Loughran, 2018). According to the notes in the annual report of Nanosonics, the company discloses that it is exposed to the foreign exchange risk and credit risk which is related to the sales. As for foreign currency risk, the company mainly has three kinds of currencies: USD, GBP and EUR, and USD take the largest proportion among them. When there is a change of 5% decrease in rate of USD, the company will lose money of $1344, 000 in 2017 and $1830, 000 in 2016, both of which are more than the materiality level. As for credit risk, the analysis of the credit policy of trade receivable shows that both in 2017 ($21,000) and 2016 ($9,000), the money exposed to this risk is over the materiality level. As a result, the inherent risk is high. Although the company adopt some measures such as foreign currency forward contracts and credit insurance to reduce these two risks, they do not work efficiently. Also, it is difficult to make sure if the balance of this account is

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correctly recorded because the types of transactions are too many and the fair value of services is hard to estimate, so the company’s control risk is still high. With the analysis above, the inherent risk and control risk in sales of goods and services are both high. According to the audit risk model, the detection risk is low and the audit risk is low. 2. Cash and cash equivalents Cash and cash equivalents of Nanosonics involves cash on hand, cash at bank and liquid investments that can be converted to cash at any time, and the cash term investments are measured at the market value. The balance in cash account can be proved by the cash receipts collected from the customers and by the bank records. According to the note of the report of the company, cash and cash equivalents are exposed to the risk of interest rate, credit and liquidity. The credit risk is the carrying amount of this account which is $62,989 in 2017 and $48,841 in 2016, which is totally significant to the company. This kind of risk is mainly influenced by the geographical location and the nature of the customers. Trade receivable of the company is from North America in major including nearly half from distributors and half from end-use customers. The interest rate risk of Nanosonics is happened when the company put the money in the bank or buys some short term deposits. The chart of company’s sensitivity to the interest rate risk shows when the interest rate increases by 25 basis points; the impact on the profit of the company in 2017 is $140,000 and $118,000 in 2016, which are definitely not material to the company. The company has $46 million in 2017 and $ 31 million in 2016 of short term deposits to get ready for the liquidity risk, so this kind of risk will rarely influence the company. As a result, the inherent of the company should be medium. As for control risk, although the risk management of credit insurance is not efficient and the interest risk cannot be controlled, the accuracy of the record can be ensured by the evidences, so the control risk is supposed to be medium. According to the audit risk model, when the inherent risk and control risk are both medium, the detection risk is medium and then the audit risk is medium. 3. Net deferred tax assets Deferred income tax is identified as the differences arising between the tax bases of assets and liabilities and the their carrying amount in the financial statements using the liability method. It is necessary to make significance judgment when determining the amount of this account that can be recognized. Deferred tax asset and liability should be classified as non-current asset and liability. The major of deferred tax assets recognized of Nanosonics includes nonrefundable R&D tax credits, taxes losses, share-based payments, employee benefits liability and patent costs, while the unrecognized deferred tax asset is the amount of estimated unrealized tax losses, up to $3 million in 2017 and $18 million in 2016. The big difference between the two financial years is mainly caused by the change of company’s policy and the utilization of carried forward tax losses. The non-routine policy change makes the inherent risk high. The inherent risk also includes if the recognition of this account accords with the 8

applicable accounting standards. Due to the complexity of the calculation process, it is easy to make misstatement. As a result, the inherent risk of deferred income tax is high. It is difficult to internally control these kinds of risks, so the control risk is also high. According to the audit risk model, the inherent risk and control risk are high, then the detection risk is low and the audit risk is low. 4. Income tax benefit/(expenses) Nanosonics of Australia is a wholly-owned entity as a part of a tax consolidated group and taxed as a single entity. Income tax benefit or expense is defined as the tax benefit or payable during the financial period, which is mainly changed due to the deferred tax assets and liabilities. It is measured with tax rates enacted at the reporting date. The income tax benefit/expenses is composed of current tax and deferred tax, among which the deferred tax takes the larger proportion achieving almost 70% of the total. The current tax expense is $8 million in 2017 and $3 million in 2016. It depends on the profit earned at the financial period, and the sales are sensitive to the demands of the products, the inflation rate, and the market share of the company. However, at the end of the financial year, the company gets income tax revenue after considering the deferred tax asset. It means that deferred tax is an essential part in income tax benefit/expenses, and it has already been analyzed above. As a result, the inherent risk and control risk of income tax benefit are both high. According to the audit risk model, when the inherent and control risk are high, the detection risk is low and then the audit risk is low. 5. Accumulated losses Accumulated losses are a negative account of equity. It means the company has not earned enough profit to make up its loss. For the balance sheet, the accumulated losses in 2016 were $6 million, and in 2017, the balance of the account was $4 million. It means that the company earned $2 million profit at this financial year. Loss is related to both the revenue and the expense in the income statement during the financial year. The inherent risk is high for revenue as analyzed above. The main expenses contain cost of sales, selling and general expenses, administration expenses and research and development expenses. Most of them are routine transactions, the inherent risk is medium. Profit and loss mainly depends on the revenue the company earns. As a result, the inherent risk of the accumulated losses account is high. Because there are many transactions related to this account, it is really difficult to control the risk. The control risk of this account is high. According to the audit risk model, when the inherent and control risk are high, the detection risk is low and then the audit risk is low.

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4. Conclusion In conclusion, through understanding the industry regulatory and other external factors, objectives and strategies, related accounting policies and the nature of the company, we can measure its financial performance and analyze its related business risks. We use simple comparison method of analytical procedure to identify the top five significant accounts that are at most risk of being misstatement. With the materiality level of $337,535, it can be seen that sales of goods and services, net deferred tax assets, accumulated losses and income tax benefits are with low audit risk, while the cash and cash equivalents are with medium audit risk.

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5. Appendix

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6. References Harriswilliams 2015, Infection Prevention Market Overview, viewed on 6th May 2018,

Loughran, M 2018, Assessing the Inherent Risk of Selling Goods and Services, Dummies, viewed on 7th May 2018,

Nanosonics 2017, Nanosonics Annual Report, viewed on 6th May 2018,

Nanosonics 2017, Nanosonics’ Story, viewed on 6th May 2018,

Nibusinessinfo 2018, Measure performance and set targets, viewed on 6th May 2018,

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